This will hurt us more than it hurts them

People arguing the case for cuts will sometimes claim that recent international experience shows that “spending cuts adopted to reduce deficits have been associated with economic expansions rather than recessions.” The quotation comes from a paper published last year by Alesina and Ardagna (subscription) that lists examples where it is claimed that countries that carried out a large-scale deficit reduction were rewarded with economic expansion and a falling debt-to-GDP ratio.

A paper published yesterday by the Roosevelt Institute studies these examples and finds that they show nothing of the sort. In fact, cutting during a slump “often results in lower growth and/or higher debt-to-GDP ratios. In very few circumstances are countries able to successfully cut during a slump, and this happens only when either interest rates and/or the exchange rates fall sharply.”

The original paper (“Large Changes in Fiscal Policy: Taxes Versus Spending” by Alberto Alesina and Silvia Ardagna for the US National Bureau of Economic Research) is more frequently used in arguments about whether tax increases or spending cuts should predominate in fiscal consolidations during slumps. But it does make the claim that, in 17 of the 26 examples studied, cuts are linked to expansion not recession.

The new paper (“The Boom Not The Slump: The Right Time For Austerity” by Arjun Jayadev and Mike Konczal) finds that many (19) of Alesina and Ardagna’s examples are actually of cuts that were carried out during a boom, not a slump. In fact, in 10 cases, growth actually slowed during the 3-year period after the adjustment.

On average, the growth rate in the year preceding the fiscal adjustment was 4.1 per cent – that is, Alesina and Ardagna’s “examples of successful consolidation were, on average, growing strongly the year before the year of adjustment.”

Jayadev and Konczal find that there are just two cases in the Alesina and Ardagna list where deficits were reduced during a recession without a negative impact on subsequent growth rates. One is Norway in 1983 – which Alesina and Ardagna do not include in their list of 17 successful adjustments. This is probably because the debt to GDP ratio grew from 20.83 per cent in 1983 to 34 per cent in 1986.

The other is Ireland in 1987. Jayadev and Konczal point out that Ireland actually went through two attempts at fiscal consolidation in the 1980s, the first of which, from 1983 to 1986, was “very unsuccessful.”

What was different in 1987 was not that the government was more committed to cuts, but that:

The £Ir was devalued by 10 per cent in 1986;

Interest rates were much lower in Ireland than in Germany and the UK and

The ‘Lawson boom’ was boosting demand in Ireland’s main trading partner.

All these factors produced the ideal environment for an export-led recovery that is unlikely to be re-created:

The £GB has already devalued against the Euro, and is in fact starting to recover;

Between 1986 and 1988 the interest rate differential between the £IR and the DM improved by 5 per centage points whilst that between the £IR and the £GB improved by 4.5 – we are very unlikely to see an equivalent improvement compared with the Euro or $;

Our trading partners, far from creating booms that will attract imports, are engaging in competitive cutting that is likely to hold down their growth.

Jayadev and Konczal start their paper with a quotation from Keynes in 1937 that seems ideal for closing this post:

“The boom, not the slump, is the right time for austerity at the Treasury.”

Written by Richard Exell

I am the TUC’s Senior Policy Officer covering social security, tax credits and labour market issues, including the debates about the European social model and labour market flexibility. I also represent the TUC on the Industrial Injuries Advisory C…

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